According to researchers at the University of Michigan, their consumer sentiment index rose to 103.2 from 92.6 in December. The increase was above the consensus forecast of Wall Street economists. Get the full story.

"With the economic recovery expected to continue and job growth gradually accelerate, confidence should continue to improve," said Scott Hoyt, economist with Economy.com.

Improved sentiment could equate to higher spending and undermine the low-inflation view that has driven Treasury prices higher, and yields to multimonth lows, this week. Inflation chisels away at the value of bonds.

Still, the market remains underpinned by bets the Federal Reserve will be slow to raise U.S. interest rates this year, ideas that were reinforced by Fed comments this week. See the Economics and Politics page.

"It seems likely that increases going forward are more modest than January's jump," Hoyt said. "The last time confidence was at this level, job gains were higher than what has been reported in recent months."

At the early 2 p.m. close, a 10-year note was down 15/32 at 101 24/32. Its yield
TNX, +1.18%
stood at 4.03 percent. Thursday's close at 3.96 percent was the lowest close since Oct. 1. Yields and prices move inversely. Yields measure the return on the investment minus the price paid.

Some investors used the sentiment data as an excuse to book profits, traders said. The 10-year yield did briefly prick the late-September intraday low of 3.93 percent early in Friday's session.

Notes and bonds were gainers on the week, however. A 10-year note was yielding 4.10 percent last Friday.

"Inflation is likely to remain under wraps this year, even in the face of the sharp rebound in economic activity, the significant rise in materials prices and the steep drop in the dollar," said Robert DiClemente, economist with Citigroup.

"The key restraint on inflation is the high degree of slack in the economy, reflecting both the legacy of recession and booming productivity trends," he said.

Mortgage impact

Bond traders said a 3.90-percent yield likely marked an area that would spark mortgage-related buying of Treasurys. In fact, Treasurys were supported this week in anticipation that falling yields would reignite mortgage activity.

Falling yields raise the likelihood of early home-loan payoffs. Mortgage funds typically replace that lost interest stream with Treasury investments. But the action launches a cycle in which the extra government bond buying puts more downward pressure on rates, leading to even more early loan payoffs, and so on.

The bond market was supported Friday on a Treasury Department report showing foreigners increased their U.S. investments in November compared with October. Read more.

The capital flows report helped the dollar rally on Friday. See Currencies.

Fed not worried

Short-term interest-rate futures contracts show the bond market thinks a Fed rate increase won't happen before August, and that any move is likely to be confined to a quarter percentage point.

Richmond Federal Reserve President Alfred Broaddus said in a speech Friday that he believes "inflation will stay under wraps this year."

"I'll let you draw your own conclusions about what that may imply for our policy settings," he added.

Philadelphia Federal Reserve President Anthony Santomero told a New Jersey business group in a speech Thursday night that short-term interest rates weren't likely moving soon.

"Assuming that the recovery proceeds as most economists expect, inflation will remain relatively stable and we are likely to see little price pressure. At the same time, the labor market will need time to absorb those currently unemployed, and, accordingly, it is likely to remain relatively slack in the near term," he said.

"Under these circumstances, it would be appropriate for monetary policy to maintain its current accommodative stance."

Industrial output in the United States rose 0.1 percent in December, the Federal Reserve said Friday. Wall Street economists polled by CBS MarketWatch had predicted a 0.4 percent gain in the month.

Capacity utilization was unchanged from a revised 75.8 percent, the highest in more than a year and roughly in line with forecasts. Get the full story.

Also reported, U.S. business inventories increased 0.3 percent in November, keeping pace with the 0.5 percent rise in sales, the Commerce Department said Friday. The inventory-to-sales ratio remained at a record low 1.35 in November. Read more.

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